Growth And Growth Policy

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GROWTH AND GROWTH POLICY

MD Siyam HossainMD Siyam HossainBangladesh Institute of Business & Technology.Bangladesh Institute of Business & Technology.Narayangonj,DhakaNarayangonj,DhakaDhaka,BangladeshDhaka,Bangladeshwww.facebook.com/mdsiyamhossain

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Determinants of GDP Growth

It is known that GDP volume and growth are determined by: a) The savings rate, b) The rate of population growth, and c) The rate of technical progress

Technology is a key determinant of growth However, these countries need not effort to invent new

technology They can grow by ‘borrowing’ technology and by

investing in physical and human capita1 Model has been developed to explain how new

technology lead to development It is called endogenous growth theory

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1. GROWTH THEORY: ENDOGENOUS GROWTH

Neo-classical growth theory illustrates that: Growth depends on technological progress Savings and growth rates are uncorrelated in steady state It dominated economic thought from 1950 to 1980

By1980s dissatisfaction arose with neo-classical growth theory

Savings rates and growth are positively correlated across countries

Neo-classical growth theory does not mention the determinants of technological progress

Present development in developed countries does not support the prediction of neo-classical growth

So, endogenous growth theory was developed

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2. THE ENDOGENOUS GROWTH THEORY

Solution to above theoretical and empirical problem with neoclassical theory lies in:

Modifying the assumed shape of the production function

Neo-classical theory states that: Steady state is achieved at a point where savings and

investment requirement lines cross Because of d.m.p of capital production function and

savings curve flatten out and cross So, long savings line is above investment requirement

line economy grows because capital is added And economy moves over time to right

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Question is how do we know that: Development process reaches steady state and halts As investment requirement line has a constant positive

slope, and savings and production line flatten out in long run, investment requirement line and savings curve are guaranteed to cross

Endogenous growth theory (Figure -1) Assumes constant marginal product of capital Production and savings curve are straight lines Saving is everywhere greater than required investment Savings curve no longer flattens out Higher is savings rate bigger is gap between saving and

investment and faster is growth (Figure -1)

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Figure -1: Production and saving function in endogenous growth theory 

Y Output per head (k)

  s(k)

(n+d)k

k Capital per head

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Endogenous growth theory presumes capital as only factor for growth, so:

Y = aK (1) Y= a K (2) Y/Y = a K/Y [Dividing (2) with Y] Y/Y = aK/aK [Putting Y = aK] Y/Y = K/K y = k [Putting y = Y/Y] (3)

Equation (3) says that output is proportional to the capital stock

Endogenous growth theory further assumes that: Savings rate is constant, s, There is neither population growth nor depreciation

of capital, and

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There is neither population growth nor depreciation of capital, and all saving goes to increase capital stock. So: K = sY K = s (aK) [As Y = ak] K/K = sa (4)

Equation (4) says that growth rate of capital is proportional to savings rate

From equation (3) and (4) we have: Y/Y = sa [K/K =Y/Y] (5)

Equation (5) expresses that growth rate of output is proportional to savings

Higher is savings rate higher is growth rate of output

This is assumption of endogenous growth theory

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Savings and Investment

Higher the savings rate chosen by a society, higher the steady state capital and income

Higher is k, greater investment required just to maintain capital-labour ratio

Hence, higher is k les is consumption So, too high a savings rate can lead to high income but low

consumption If steady-state consumption is c* If steady-state income equals y* = f (k*) and And steady state investment is (n + d) k*, then c* = (k*) – (n + d)k* Steady state consumption is maximised, when just enough

invested to cover the increased output Above this level, saving should be cut and more consumed Below this level, consumption should be increased

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3. THE DEEPER ECONOMICS OF ENDOGENOUS GROWTH

Difference between neo-classical and endogenous growth theory: Endogenous eliminates law of diminishing marginal returns This violates one of the basic microeconomic principles It imposes constant returns to scale on capital

This implies that: Firms with twice as much machinery capital produces twice as

much output If doubling capital doubles output, doubling all factors of

production (labour) will more than double the output It means that there is increasing return to scale when all factors

are taken together This suggests that larger and larger firms are more efficient It means that ultimately a single firm comes to dominate

ultimately entire economy

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Practically, there is no monopoly because: Individual firm cannot capture all benefits of constant returns

to scale at same time Some of the benefits remain external to firm That some firms have this factor and some firms have others

factor of constant returns to scale When a firm increases its capital, production increases Productivity of other firms increases also Hence, there is no monopolisation of the economy

Endogenous growth theory separates different capitals: There are not only new machines but new ways of doing things Some firms assume technological advantage because of research Some assume unforeseen (unexpected) opportunity Benefits of new machines can be copied But benefits of new methods and new ideas are not easy to copy Hence monopolisation is hold up

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4. CONVERGENCE Endogenous growth theory predicts convergence for economies It predicts all economies should reach same steady state and

same per capita income ultimately It assumes that a high savings rate leads to a high growth rate Countries those invest more grow faster However, impact of higher investment on growth is transitory Country with higher investment achieves higher per capita

income But after that the growth rate slows down

For Endogenous growth theory: Countries converge conditionally Those save and invest more converses fast Those save and invest les converses slowly Hence, international differences in growth rates and per capita

income sustain

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Endogenous growth theory remarks that:

Convergence is taking place at a rate of 2% annually India’s income level was 5% of that of USA in 90s Hence, India will achieve the US leve1 in 151 years

However, the period of convergence could be shorten considerably by:

Increasing savings rate, population growth, labour productivity in India

Some of such options are discussed below

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IllustrationsLet per capita income of USA and India in 2005 are $35000 and $700 respectively. If per capita income of India converges at the rate of 2%, 5%, 8% 10% and 15% to that of USA, how many years India will require achieving USA standard

Let the convergence rate is 2%

India’s present per capita income is $ 700

US present per capita income is $ 35000

India is converging at the rate 2% to the USA

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We know that:

Future Income = Present Income (1+r)n

Where n is the years and r is the rate of growth 35000 = 700 (1+2%) n

50 = (1+2/100) n

Log 50 = Log (102/100) n

Log 50 = n [Log 102 – Log 100) 1.699 = n [2.0086 – 2] 1.699 = n . 0086 n = 197 Years It means India requires 197 years to converse to USA

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Let the convergence rate is 5%

We know that:

Future Income = Present Income (1+r)n

Where n is the years and r is the rate of growth

35000 = 700 (1+5%) n

50 = (1+5/100) n

Log 50 = Log (105/100) n

Log 50 = n [Log 105 – Log 100) 1.699 = n [2.0212 – 2] 1.699 = n . 0212 n = 84 Years It means India requires 84 years to converse to USA

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Let the convergence rate is 8%

We know that:

Future Income = Present Income (1+r)n

Where n is the years and r is the rate of growth

35000 = 700 (1+8%) n

50 = (1+8/100) n

Log 50 = Log (108/100) n

Log 50 = n [Log 108 – Log 100) 1.699 = n [2.0334 – 2] 1.699 = n . 0334 n = 51 Years It means India requires 51 years to converse to USA

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Let the convergence rate is 10%

We know that:

Future Income = Present Income (1+r)n

Where n is the years and r is the rate of growth

35000 = 700 (1+10%) n

50 = (1+10/100) n

Log 50 = Log (110/100) n

Log 50 = n [Log 110 – Log 100) 1.699 = n [2.0414 – 2] 1.699 = n . 0414 n = 41 Years It means India requires 41 years to converse to USA

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Let the convergence rate is 12%

We know that: Future Income = Present Income (1+r)n

Where n is the years and r is the rate of growth 35000 = 700 (1+12%) n

35000 = 700(1+12/100) n

Log 50 = Log (112/100) n

Log 50 = n [Log 112 – Log 100) 1.699 = n [2.0792 – 2] 1.699 = n . 0492 n = 34.67 Years It means India requires 21.4 years to converse to USA

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Let the convergence rate is 15%

We know that:

Future Income = Present Income (1+r)n

Where n is the years and r is the rate of growth

35000 = 700 (1+15%) n

50 = (1+15/100) n

Log 50 = Log (115/100) n

Log 50 = n [Log 115 – Log 100) 1.699 = n [2.0607 – 2] 1.699 = n . 0607 n = 27 Years It means India requires 27 years to converse to USA

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Up to 1990 India conversed only at rate of 2%So, she had to wait 151 years to achieve USA standard However, relying on neo-classical force of convergence, India cannot look forward to catch up with USA

If, India saves and invests more as Endogenous Growth Theory predicts:

It can magically reduce the convergence period as above

If it can achieve only a growth rate of 8% annually that She is doing now: Convergence time is reduced to only 50 years This is true for all developing countries

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Actually India convergence rate is 8%

We know that:Future Income = Present Income (1+r)n

Where n is the years and r is the rate of growth

35000 = 700 (1+8%) n

50 = (1+8/100) n

Log 50 = Log (108/100) n

Log 50 = n [Log 108 – Log 100)1.699 = n [2.0334 – 2]1.699 = n . 0334n = 50 YearsIt means India requires 50 years to converse to income

of USA

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5. GROWTH TRAPS AND TWO SECTOR MODELS

Explaining high or low growth is not the same as explaining no growth

No growth was most accurate for Bangladesh from l820 to 1990

To explain no-growth and high growth, both neo-classical and endogenous growth theories is used

There are two kinds of investment opportunitiesSome investments follow the law of diminishing

marginal productSome others follow rule of constant marginal

product So, society must ensure high investment And choose investment in sectors that follow constant

marginal product

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Societies investing in research and development have ongoing growth

Because it helps developing technology for high-growth Societies that direct investment toward physical

capital may have higher output in the short run but at the cost of lower long-run growth

Least developed countries Low-income causes les savings Les savings do not meet capital requirement for growth So, growth rate remains low, which leads to low a steady

growth state At high income savings and investments are more than

the capital requirement It leads to ongoing growth

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6. PULATION GROWTH AND ECONOMIC GROWTH

Regarding population growth one oldest view is that: Population growth functions against achievement of

high incomes

Solow’s growth model predicts that High population growth (n) means lower income

(and lower steady growth state) Because high population growth means less capital

per worker

Rich Countries With rising incomes birth rates fall Rich countries are approaching zero population

growth

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Poor Countries Poor countries have high birth resulting high

population growth And as incomes rise, death rates fall and population

growth rises Poor countries are recognizing need to reduce

population growth So, contraceptives are being persuaded and policies

instituted Reducing population growth in poor countries is

difficult In poor countries large families function as a social

security system Children ensures that parents are taken care of in their

old age

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8. LESSONS FROM THE ASIAN TIGERS

Because of high economic growth and quick development

Hong Kong, Singapore, South Korea, and Taiwan are called ‘Asian Tigers’

From 1966 to 2000 per capita GDP grew annually in average in (Slide-31): Hong Kong 5.7% Singapore 6.8% South Korea 6.8% Taiwan 6.7% They are seen as model for developing countries

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They followed some policies, which are worthy of copying: These are hard work and sacrifice

These countries have: Saved more and invested more Put more people to work

Hence, labour force increased from 1966 to 2000 in (Slide-31): Hong Kong 38-49% Singapore 27-51% South Korea 27-36% Taiwan 27-37%

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They concentrated on education in order to raise human capital

People with SSC and Higher Education grew from 1966 to 2000 in (Slide-31):

Hong Kong 27-71% Singapore 16-66% South Korea 27-75% Taiwan 26-68% Total Factor Productivity in these countries

however, did not grew fast

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From 1966 to 2000 TFP grew only (Slide-31):

2.3 times in Hong Kong 0.2 times in Singapore 1.7 times in South Korea 2.6 times Taiwan They have relatively stable governments They follow an export-oriented economic policy Encourage their industries to export They liberalize their market and encourage their

industries to compete in free market They directed their investments

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Table 4.1: Growth in the Tiger Countries (1966-2000)

  Hong Kong Singapore South Korea Taiwan

Per Capita GDP Growth 5.7 6.8 6.8 6.7

TFP Growth 2.3 0.2 1.7 2.6

Growth of Labour force 38-49 27-51 27-36 28-37

Growth of SSC & Higher Education

27-71 16-66 27-75 26-68

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They have encouraged foreign investment to bring in new technologies

The Tigers Countries have achieved something extraordinary in human history

Their high growth rate transformed them from poorest countries to rich countries

This is done in the old-fashioned way

Through saving, investment, hard work and competition

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9. THE GROWTH OF POOR COUNTRIES

Growth line for Bangladesh illustrates a striking problem

Compared to rest of world, Bangladesh hasn't had any economic growth up to 1990

Some is true for a number of other countries: Burma, Nepal, Afghanistan, etc

Income is so low that much of the population lives under subsistence

Savings in these countries are very low From 1960 to 1985 investment in Bangladesh was

only 4.6% of GDP In the same time, it was 36.6% to 24% in Japan and

USA respectively

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Population growth in Bangladesh was also much higher than in Japan & USA

For Bangladesh, both savings and population growth determined GDP

Poor countries are hard pressed to invest in human capital

They have hostile climates for foreign investment Some of theme encourage domestic production and

discourage foreign investment Economic and legal environment are uncertain for

foreign investment They are unwilling or unable to guarantee investors to

repatriate profits